ACCA PM Syllabus C. Decision-making Techniques - Price Elasticity of Demand - Notes ^{2 / 6}

Generally, it is expected that there will be an inverse relationship between selling price and sales demand.

If the selling price is increased, sales demand would be expected to fall.

If the selling price is reduced, sales demand would be expected to rise.

The key question is ‘to what extent is demand likely to respond to a change in price?’

The price elasticity of demand (i.e. the degree of sensitivity of demand for a product to changes in the price of that product) can be measured as:

% change in sales demand
--------------------------------
% change in selling price

If the % change in demand > the % change in price then price elasticity > 1. Demand is ‘elastic’, i.e. very responsive. Total revenue increases when price is reduced, and decreases when price is increased.

If the % change in demand < the % change in price, then price elasticity < 1. Demand is ‘inelastic’, i.e. not very responsive. Total revenue decreases when price is reduced, and increases when price is increased.

Price elasticity of 1 will mean that the % change in demand offsets the % change in price, leaving total sales revenue unchanged. An increase in selling price will be offset by a decrease in sales demand: a decrease in selling price will be offset by an increase in sales demand.

Illustration

At a price of $1.50, annual demand is 100,000.

If price is increased to $1.75, annual demand is 80,000

Price elasticity of demand is: -

% change in demand = 20,000/100,000 x 100 = -20%

% change in price = 0.25/1.50 x 100 = 16.67%

Price elasticity of demand is 20/16.67 = 1.2 (ignore the minus sign)